Can Rich Countries Afford to Grow Old?

Observers in many industrialized countries believe population aging represents a serious economic threat. Increases in the percentage of the population past retirement age may impose unsustainable burdens on future workers. Either taxes or government debt will have to rise substantially to pay for old-age income support. This paper considers the extent of these burdens and corrects the widespread impression that the burdens are unsupportable. Population aging means that contributions needed to support the retired elderly must rise. But this extra burden will be at least partly offset by a reduced need to support the dependent young, who will become relatively less numerous. The extra burden of an aging population would be smaller still if labor force participation rates among the working-age and elderly populations increased. Indeed, employment rates among the nonaged have risen in nearly all the industrialized countries as a growing percentage of women has entered the work force. Many countries, including the United States, have adopted policies to encourage work among people past the traditional retirement age.

From the 1940s through the 1980s, the most common policy response to old-age dependency in rich countries was to increase taxes and public income support in order to improve incomes among the aged. By the end of the 1980s most wealthy countries had achieved rough parity in the equivalent incomes received by their elderly and non-elderly populations. Faced with large prospective deficits in their pension accounts in the 1990s, governments in rich countries began to scale back future benefit promises. With few exceptions, rich nations have decided to cut future benefits in order to keep their systems affordable. If governments stick to the pension formulas adopted in recent years, public pensioners in 2050 will obtain a much smaller wage replacement rate than the one enjoyed by people who retired in the recent past. In countries such as Britain, Italy, and Japan, future replacement rates could be one-third or more lower than they are today.